David Cummings on Startups

Category: Investing

  • Investing in 100 Startups

    One of my personal life goals is to directly invest in 100 startups. There’s no real rhyme or reason to the goal other than I enjoy helping entrepreneurs and like the thrill of building companies. To date, I’ve invested in 26 startups counting ones I’ve started. At a rate of 2-5 per year, my guess is that I’ll hit the goal in 20 years.

    Here are a few thoughts about investing in 100 startups:

    • Investing money helps pay it forward for the next generation of entrepreneurs
    • Continually investing in startups is a great way to stay current and learn about new trends
    • Most investments will lose money but a handful will do really well (that’s been the case so far)
    • Many of the investments will be B2B SaaS startups but it won’t be limited to just that category
    • A sub-goal is to have at least one investment go public and one be a unicorn (valued at a billion or more)

    I’m excited by the prospect of investing in 100 startups and all the adventures that will come with it.

    What else? What are some more thoughts on investing in 100 startups

  • University-Affiliated Angel Networks

    One of the projects I’ve been helping out with recently is the Duke Angel Network. Universities have been making a stronger entrepreneurial push over the past few years and startup funding is always a challenge. With the Duke Angel Network, the idea is to review Duke-affiliated startups that have a student, alumni, faculty, staff, or parent of a graduate on the founding team and present qualified companies to angel investors that are Duke-affiliated (same criteria for affiliation).

    Startups that raise money from the Duke Angel Network then have the option for a smaller matching investment from the Duke Innovation Fund. The Duke Innovation Fund is a charitable pool of committed capital that’s an evergreen vehicle to continually invest in Duke-affiliated startups indefinitely (e.g. all fund profits go back into the fund to invest in more startups). People can donate to the Duke Innovation Fund, get a charitable deduction, and know that the money will go to help the Duke-affiliated startups in perpetuity.

    Here are a few thoughts on university-affiliated angel networks:

    • Part of the pitch is that investing with a network of angels, whereby there are more people with expertise for any specific deal, will increase the overall returns (I’m hopeful this plays out but I don’t believe it will be the case)
    • Increasing tech transfer (licensing university developed IP) is also a goal such that the more commercialization of technology – funded by the affiliated angel network – will generate greater returns for the university
    • Development offices are fans of university-affiliated angel networks as it can help increase the affinity for the university and generate more engagement

    Look for more university-affiliated angel networks to emerge, especially as entrepreneurship remains hot and universities seek to engage with their constituents.

    What else? What are some more thoughts on university-affiliated angel networks?

  • Tranche Investments in Startups

    Over the past year I’ve seen a little-used investment strategy come up a few times: the tranche. With a tranche, money is typically invested over two or three milestones based on the progress of the company (often at the will of the investor, and sometimes contingent on the entrepreneur’s approval). As an example, $250,000 might be put in immediately, and within the next six months, the investor has the option to put in an additional $250,000 at the same terms.

    Clearly, this is a nice benefit for the investor as they can see how the company performs before putting in the additional money, and if the company does well, the second part of the tranche investment is a better deal because the company is worth more as the investor is buying the equity at the previous valuation. Only, there are a few more nuances at play as well. Here are some thoughts on tranche investments:

    • Entrepreneurs almost always operate, and spend, as if the later round(s) of the tranche are going to come in, creating challenges if the business doesn’t perform as expected
    • Tranches often make the entrepreneur more beholden to the investor (possibly filtering the news to make things sound more promising) as they want to ensure that the next round of money comes in, and this can distract from growing the business
    • Tranches can be more distracting as they usually have a shorter timeframe – say three or six months – between milestones as opposed to the typical 12-24 months between financings
    • From a valuation perspective, tranches can be thought of as the average of the current valuation and the projected valuation(s) at the later milestones, such that the investor gets a bonus if the company does better than expected

    Entrepreneurs typically want to avoid tranches and focus on negotiating a fixed investment amount upfront, so that they know how much money and runway they have to grow the business before raising another round.

    What else? What are some more thoughts on tranche investments in startups?

  • SaaS at 3x Revenue – Xactly Follow-up

    As a follow-up to last week’s post Notes from the Xactly S-1 IPO Filing, it’s useful to see how things played out for a newly public Software-as-a-Service (SaaS) company. With so much media and analysis around SaaS companies trading at large multiples (e.g. 8x or greater revenue), Xactly paints a much more realistic picture of a cloud computing company growing at a modest pace.

    Here are a few notes from the outcome of the Xactly IPO (NYSE:XTLY):

    • Market cap: $241M
    • Last quarter’s revenue annualized: $71M (last quarter’s revenue times four)
    • $241M / $71M = 3.3x (ignoring cash on hand, liabilities, etc)
    • Q1 2014 to Q1 2015 quarterly revenue growth: 16%

    So, for a SaaS company growing less than 20% per year, the revenue multiple here is roughly in the 3x range. This is a big difference from the huge premiums much faster growing companies earn (see Quantifying the SaaS Growth Rate Multiplier). For Xactly, it’ll be interesting to see if they can use the new cash on their balance sheet to increase their growth rate and command a much higher premium.

    What else? What are some more thoughts on SaaS at 3x revenue?

  • Economics of a Startup Studio

    Continuing with yesterday’s post on High Alpha Studio and Seed, let’s look at the hypothetical economics of a B2B Software-as-a-Service startup studio. Assuming $20 million to be spent over five years to build 20 startups, here’s what it might look like:

    • $4 million per year budget
    • Expenses
      • $3 million/year for 20 full-time employees plus four partners, including benefits
      • $250,000/year for office space (10,000 sq ft at $25/ft)
      • $50,000/year for office items (equipment, supplies, etc.)
      • $100,000/year for legal and accounting
      • $100,000/year for software
      • $100,000/year for miscellaneous
      • $300,000/year for marketing/advertising (this is for the products created, not the studio itself)
      • $100,000/year held in reserve for years after the five years to manage the studio’s responsibilities
    • 20 startups created
      • 10 fail (minimum respectable product built, beta customers signed on, and the plug pulled for one reason or another)
      • 10 raise outside financing (or at least raise money from the separate investment fund)
        • Average ownership stake before outside financing: 75% (assume 25% for the management team and employees)
        • Average ownership stake after outside financing: 56% (assuming 25% dilution)
    • Outcome needed to be successful
      • $80 million in aggregate equity value to generate 4 times the $20 million invested resulting in a 3x return to investors (roughly 1x of return goes to the partners in the studio – see Investor IRR on Paper to Raise Another Fund)
      • With 10 startups, that’s an average of $8 million in equity value per startup
      • With an average 56% ownership stake, that’s an average startup valuation of $14.3 million (so, $143 million in total value for the 10 startups)

    While the studio would produce a number of startups, the reality is that the financial outcomes of the startups produced are more likely to be lopsided where one or two produce the vast majority of the returns and most aren’t worthwhile. Regardless, the economics of building a studio to build SaaS companies is appealing, especially in today’s hot market.

    What else? What are some more thoughts on the economics of a startup studio?

  • Ask Investors for Help

    Early this week I was talking to an entrepreneur about his company, market, competitors, and investors. When asking about his investors, he said they were great but super hands-off. Probing deeper, he said he has to reach out to them for help as things are very casual. After thinking about it, I think this happens more often than expected and that entrepreneurs should be more proactive about asking investors for help.

    Here are a few thoughts on asking investors for help:

    • Most investors want to add value, so asking for help isn’t imposing
    • Include asks for help in the regular investor updates
    • Before an investor writes a check, ask them how they’d like to help, if at all (if they’ve already invested, and you don’t already know the answer, ask this question)
    • Consider the area of expertise for each investor, and lean on them when a relevant question comes up

    Investors do want to help and many entrepreneurs don’t regularly seek them out even though they have a vested interest in the success of the startup. Entrepreneurs should ask investors for help more often.

    What else? What are some more thoughts on asking investors for help?

  • Startup Pitch Deck Examples and Template

    Alexander Jarvis has a solid post up titled Pitch Deck Collection from VC Funded Startups. With 40+ pitch decks, there are a number of excellent examples to review. I especially love seeing artifacts from the early days of major success stories like LinkedIn and Airbnb. Taking the Airbnb deck as a template, here are the slides:

    • Welcome
    • Problem
    • Solution
    • Market Validation
    • Market Size
    • Product
    • Business Model
    • Market Adoption
    • Competition
    • Competitive Advantages

    Add in a Team and Summary slide and that’s a great format for entrepreneurs to copy. Pitch decks should tell a story and convince the potential investor that’s it worthwhile to spend more time on the opportunity.

    What else? What are some other items you look for in a startup pitch deck?

  • Venture Fund Cash Flow Considerations

    Continuing with yesterday’s post on the insider view into the venture world, there’s another element of venture funds that I didn’t understand and that’s around cash flow. At first, it seems like if a venture fund is $50 million, then they have $50 million to put to work immediately. In reality, it’s much more complicated.

    Here are a few nuances around cash flow in a venture fund:

    • Capital is committed by investors and then called as needed (e.g. a limited partner makes a commitment of $1 million and each call might be for roughly 10% of the commitment, so an investor would have to wire $100,000 within 10 days).
    • Funds work hard to minimize the number of capital calls to keep things simple for limited partners and often use a line of credit to smooth things over (e.g. shoot for 2-3 capital calls per year, but if there’s additional investment activity between the calls, use the line to move quickly and make another investment).
    • If the fund has some early exits, there’s a real chance that the limited partners don’t have to invest their full commitment because the proceeds from the exits will cover some of the capital (e.g. with some wins, a commitment of $1 million might only result in $700,000 in money invested by the limited partner).
    • Since capital is called over the course of the investment period, typically 3-5 years, and done in a piecemeal fashion, investing $1 million in a venture fund doesn’t require having $1 million in cash, but rather ~$200,000 per year for five years.

    Commitments, capital calls, a line of credit, and exit proceeds make cash flow in a venture fund more challenging than expected. The next time you read about financing from a venture fund, think about everything that went into it.

    What else? What are some more thoughts on cash flow considerations in a venture fund?

  • Viewing the Venture World as an LP

    After we sold Pardot, I decided to invest in a few venture funds as a limited partner. While I want to receive great returns (e.g. 3x cash on cash), I’m even more interested in understanding how venture works and what it looks like from the inside. After a number of conversations, quarterly updates, and annual meetings, I have a few thoughts on the venture world as it operates in Atlanta:

    • Making good returns is much more difficult than it seems. While there isn’t much venture capital locally, it’s still difficult to find investable opportunities.
    • Most of the Atlanta-based venture firms do a substantial number of deals outside of Georgia.
    • Even investing in startups with a minimum of a million in revenue and great growth rates doesn’t guarantee success. In fact, several investments in companies that met that criteria became worthless.
    • Investments in startups and entrepreneurs that are a dud take substantially more time and energy than the ones that do well, so picking correctly at the onset is more critical than expected.
    • Valuations are a major topic, with a heavy focus on getting good deals (read: low valuations), as the goal is to swing for singles and doubles.

    Being a limited partner in several venture funds has given me a greater appreciation for the difficulty of being an institutional investor. I’m looking forward to learning more as the funds progress through their lifecycle.

    What else? What are some more thoughts on the venture world from the inside?

  • Thiel’s Paradox

    The New Yorker has a fascinating piece on Marc Andreessen, a well known entrepreneur and venture capitalist, titled Tomorrow’s Advance Man. In addition to a number of excellent stories, the author mentions Thiel’s Paradox from early Facebook investor Peter Thiel:

    When a reputable venture firm leads two consecutive rounds of investment in a company, Andreessen told me, Thiel believes that that is “a screaming buy signal, and the bigger the markup on the last round the more undervalued the company is.” Thiel’s point, which takes a moment to digest, is that, when a company grows extremely rapidly, even its bullish V.C.s, having recently set a relatively low value on the previous round, will be slightly stuck in the past. The faster the growth, the farther behind they’ll be. Andreessen grinned, appreciating the paradox: the more they paid for Mixpanel—according to Thiel, anyway—the better a deal they’d be getting.

    Generally, entrepreneurs want to bring in new investors for each round of funding so that they can create an auction-like environment to get the best combination of valuation and value-add. Thiel’s Paradox is that for entrepreneurs of fast growing companies, an insider round from existing investors, no matter the valuation, results in a good deal for investors. The next time you read about a startup raising another round of funding exclusively from the existing investors, think about Thiel’s Paradox.

    What else? What are some more thoughts on Thiel’s Paradox?